China’s long-term potential for investors remains unrivalled

The struggling property and retail sectors might raise questions, but the yuan's growing importance as an alternative reserve currency shows the path ahead

By Zainab Faisal Kufaishi

September 12, 2022

Apartment blocks under construction in Beijing, seen on July 15. China surprised many by cutting its loan prime rates

China’s surprise decision to cut its one-year and five-year loan prime rates comes as most developed nations are hiking interest rates to tackle spiralling inflation.

Yet the People’s Bank of China’s move – reducing the one-year rate by 5 basis points to 3.65 percent and the five-year rate by 15 points to 4.3 percent – has to be set in the context of a failing property market and a sudden drop in retail sales. It should not detract sovereign investors from the country’s vast potential.

The challenges of the real estate market risk spilling over into other sectors, threatening China’s wider economy and slowing global growth. With retail sales rising by only 2.7 percent year-on-year in July, a slowdown in consumption is of concern. So, are lower rates enough to reverse the property decline?

The cut in rates is a sign that policymakers in China are taking significant steps to revive flagging housing sales and stabilise growth, but easing liquidity alone may not be enough to lead to a turnaround.

So far, the lower rates have not translated into higher property sales, primarily due to a lack of confidence in large developers and the pre-sales model. This is structural and, for the mid term, presents the sector and the wider economy with a serious challenge, threatening to weigh down on sentiment across other sectors.

But with growing confidence in the yuan renminbi, there is reason to be optimistic about China’s overall economic fortunes and long-term outlook.

The recent Invesco Global Sovereign Asset Management Study surveyed 81 sovereign wealth funds and 58 central banks with combined assets of around $23 trillion. It shows that the yuan has been steadily growing in its share of global foreign exchange portfolios, highlighting the increasing importance of China’s position within the global economy and as a key trading partner.

Across central banks, the study shows that there is wider adoption of the yuan as a reserve currency. Some 63 percent of central banks now have yuan allocations, up from 40 percent in 2018, with most banks viewing their position as currently underweight. Allocations rose from 1.1 percent of total foreign exchange reserves at the end of 2016 to 2.8 percent at the end of 2021.

The study also found that some 58.8 percent of central bank foreign reserves were denominated in US dollars at the end of 2021, almost unchanged from the 58.9 percent figure at the end of 2020.

This hints that the yuan seems to be gaining market share from alternative reserve currencies to the US dollar, which we can see as an indication of firm long-term confidence in the currency and in the Chinese economy.

Geopolitics

Global confidence in China is shared by some of its close geographic neighbours and trade partners, despite regional geopolitical questions and concerns over state interventions in sectors such as technology. What does this tell us? It shows that China is a large and growing market that cannot be ignored.

Sovereign investors in the region have shown no signs of being deterred by geopolitical events when it comes to exploring investments that will yield the best returns. They are increasingly diversifying and, due to their long investment horizons, allocate to the most important markets of the future. This means China can’t be overlooked.

For instance, while the situation in Ukraine and Russia has certainly pushed Middle East sovereigns to focus more on political risk and the rule of law, the crisis is not registering as a significant threat to the Chinese markets.

China is much more integrated into global trade and financial markets than Russia, with the interdependence of the Chinese and US economies seen as potentially mitigating some of the underlying geopolitical risk.

For sovereigns in the Gulf, assessing each opportunity on its specific merits rather than a one-size-fits-all methodology is a means to generate better returns and identify good opportunities for direct investment.

In China, the scale of opportunities is vast. Despite the challenges, there are diverse opportunities in a depressed property market, venture capital, equities, fixed income, and China’s leading role in central bank digital currency design and launch, including digital asset infrastructure.

Most Middle East sovereigns agree that, despite the headlines, China remains rich in opportunity.

Zainab Faisal Kufaishi is head of the Middle East and Africa at Invesco